There is widespread understanding that recoveries are typically weak after a balance sheet recession, like we had in 2008-2009, and the current cycle’s sluggish pace of global growth clearly fits this pattern. This is assumed to be a temporary phase, followed by an eventual return to a more normal recovery, but this has not happened yet. This begs the question…is the current situation more economically structural (longer-term) than economically cyclical (shorter-term)?
Viewing the current global economic malaise as largely cyclical is a mistake because there are powerful structural forces at work. Investors may come to understand this over the coming year. We believe that the following structural forces will slow down the return to what has been historically regarded as a “normal” recovery, which usually has been defined by GDP growth of 3-4% per year and not the 1.5-2.5% we are currently experiencing.
Debt Headwinds: As discussed in previous investment newsletters, the end of the Debt Supercycle was not a one year story, but a major regime change that could (will?) be with us for years. Current high debt burdens were built up over decades and their legacy will cast a shadow over economic growth for a long time. In the Post-Debt Supercycle world, demand will be constrained by the growth in workers’ incomes, which likely will be modest.
Globalization: The world is clearly becoming more interconnected. There was an old saying that when the U.S. sneezed, the rest of the world got a cold. Now, it doesn’t have to be the U.S., but it could be China, the Emerging Market countries or even Europe. When one part of the world gets “a cold”, because of globalization, it negatively impacts the rest of the world due to our interconnectivity.
Technological Innovations: Whether it’s 3-D printing or advanced robotics, along with narrowing labor costs (China is now building factories in India, Vietnam, etc.), the growth of traded goods will be undermined and this will lead to declines in direct investment flows. This too will be a future impediment to global growth.
In the past, monetary policies were able to help offset these “growth headwinds.” However, monetary policy has largely achieved all it can in terms of boosting growth. Interest rates cannot be pushed much lower, and in a Post-Debt Supercycle world, even zero or modestly negative interest rates (nominal rates minus inflation) cannot trigger a new credit cycle, which is what countries need to grow their way out of this economic malaise.
This leaves basically two other ways to try and jump-start global economic growth: pushing asset prices up so people feel “richer” and want to go out and spend some of this “new” wealth, or by pushing exchange rates down, which helps multi-national corporations sell more goods abroad because their prices are now cheaper to foreign buyers. Central banks have been successful in pushing up asset prices, but there is only so far they can go. Meanwhile, the ability of any one country to push its exchange rate down depends, in large part, on the policy actions of other countries.
The market’s returns were so good over the 25 year period from 1982 to 2007, primarily due to the following factors:
- A dramatic fall in inflation
- A rapid expansion of private credit
- The post-1990 opening up of the global economy
- The information technology boom
- Broad geopolitical stability due to U.S. dominance
All of the above led to an explosion of asset prices led by financial assets and real estate. So, now you might be saying…okay, so what does all of this mean for my portfolio since a lot of those “tailwinds” are behind us? For an investor who is a 100% Index investor, the Bank Credit Analyst (BCA) believes that over the next 10 years the average annualized return will be in the 4-5% area for the S&P 500 Index. This is down from a slightly over 11% annualized return from 1982 to 2015.
With respect to other developed countries, they believe the annualized return will be in the 6% area, down from slightly over 9% for the aforementioned timeframe. Bond wise, Treasuries and Corporate bonds will be in the 3-4% annualized area, half of what they have returned from 1982 to 2015. We feel that this is a great reason why it might be a struggle to be an index investor going forward.
Trying to forecast out 10 years is fraught with potential errors. We do not necessarily agree with BCA’s general return estimates for the next 10 years, but one thing we do agree on with BCA is that for the next 10 years, it is going to be very difficult to achieve double digit rates of return in the equity markets.
For instance, asset allocation and economics are why we got out of commodities well over a year ago and exited the Emerging Markets space in July and then again in November. We may return to Emerging Markets and/or commodities, but only after a number of criteria are successfully addressed such as debt levels, commodity prices, the stabilization of China’s GDP as well as the EU’s growth, etc.
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Disclaimer: This blog is intended for informational purposes only and should not be construed as individual investment advice. Actual recommendations are provided by RAA following consultation and are custom-tailored to each investor’s unique needs and circumstances. The information contained herein is from sources believed to be accurate and reliable. However, RAA accepts no legal responsibility for any errors or omissions. Investments in stocks, bonds, and mutual funds may increase or decrease in value. Past performance is no guarantee of future results. Any of the charts and graphs included in this blog are not recommendations for the purchase and sale of any security.